All new companies need funding of some sort to get started. So, where can an early-stage business get this support from?
The bank of mum and dad
The first port of call is often friends and family – they know you already and (hopefully) believe in your business. This can be a particularly helpful capital injection for early-stage founders who have no prior track record in business and who may struggle to get finance from traditional banks and lenders.
However, even at these early stages, it is very important to clarify whether such friends and family are making loans or investing equity into the business. We often see complicated arrangements for how loans would be repaid, and confusion can often arise between whether somebody is making a loan, whether it will be repaid with interest, or whether they are investing into the business and becoming an equity holder with entitlement to future dividends. This can be an incredibly sensitive area if both parties are not absolutely clear on the nature of the investment – definitely one of the downsides of lending between friends and family! A sensible conversation with a lawyer or an accountant would be strongly recommended to avoid future disagreements.
Nevertheless, not all of us are fortunate to have friends and family who are willing or able to invest into a new venture.
Grants & government support
Other sources of funding can be found from various government bodies or Innovation Grants. There can be quite stringent rules as to which companies are able to apply for certain grants, and there can be restrictions on how the money is spent if awarded. The process can be log, but it doesn’t cost you any equity and can be an important source of funding for early-stage businesses. Researching whether you are eligible for a grant if definitely worthwhile.
Many tech companies will be involved in innovative work that may qualify for R&D tax credits. This can be a useful cash injection into a business, helping to fund ongoing research. The most recent statistics from HMRC show that 85,900 claims were made in the year to March 2020 with £7.4bn of support now being claimed annually.
The R&D claim is made through the corporation tax return, which can mean a delay in when the work is undertaken compared to when a cash credit is received (following the end of the accounting period when the accounts and tax return have been completed and the R&D claim processed by HMRC). Some companies offer advance payments against future R&D claims – though this can often be at a high commission.
Online crowdfunding platforms have expanded the market considerably by enabling smaller private investors (often referred to as retail investors) to invest in start-up businesses with innovative ideas which capture people’s imagination.
However, such forms of funding are highly competitive and there’s no guarantee the funding goal will be met, which could mean the whole process needs to be restarted. Other forms of help such as pledges to buy future products can be helpful but won’t necessarily give the cash injection which early stage companies need.
Angel investors / Venture Capital
Angel investors are usually very high net worth investors who invest in start-ups with either equity or convertible loan notes (loans with the option for these loans to be converted into equity in the future).
Venture capital or private equity funds are professional firms that leverage personal and institutional capital to acquire equity holdings in private companies, in the hope that your business grows into the next Unicorn.
Venture capital or private equity funds often look for big opportunities with a proven team, though there are many different venture capital firms who specialise in companies at different stages or specific areas who may be interested in your business if they are presented with a credible business plan with sensible financial forecasts.
In order to encourage investment into small businesses, the government has various tax reliefs available to investors, such as EIS, SEIS or VCT relief.
Most investors will only commit to investing if they know that tax relief will be available, and therefore obtaining advance assurance from HMRC lets investors know that if they invest their capital in the company and it remains qualifying, they will obtain their relevant tax reliefs.
SEIS/EIS advance assurance is therefore often seen as fundamental in giving your start-up the best opportunity of securing external investment.
Such investors won’t merely invest based on a good idea (though clearly this helps). They will also want to see a credible business plan with sensible financial forecasts, along with ideally a strong sales pipeline, or some confidence that the business will have the traction it needs to grow. A strong network within the local tech community can help build this traction and get your business known to local investors.
This article is a high-level summary of areas to consider when attracting investment into your company. Your accountant should be able to guide you through how various forms of funding can impact your business. If you want an independent conversation or just a coffee to talk about this article further, please don’t hesitate to reach out directly to me, Ben or anybody else at RSM – email@example.com & firstname.lastname@example.org